Page 855 - Krugmans Economics for AP Text Book_Neat

S-9
SOLUTIONS TO AP REVIEW QUESTIONS

b. When the unemployment rate is low, frictional ings. ATM machines, for example, give customers
unemployment will account for a larger share of 24-hour access to cash in thousands of locations. This
total unemployment because other sources of unemploy- reduction in the cost of obtaining money translates into
ment will be diminished. So the share of total unemploy- lower shoe-leather costs.
ment composed of the frictionally unemployed will rise. 2. If inflation came to a complete stop for several years, the
2. A binding minimum wage represents a price floor below inflation rate of zero would be less than the expected in -
which wages cannot fall. As a result, actual wages cannot flation rate of 2–3%. Because the real interest rate is the
move toward equilibrium. So a minimum wage causes the nominal interest rate minus the inflation rate, the real
quantity of labor supplied to exceed the quantity of labor interest rates on loans would be higher than expected,
demanded. Because this surplus of labor reflects unem- and lenders would gain at the expense of borrowers.
ployed workers, it affects the unemployment rate. Borrowers would have to repay their loans with funds
Collective bargaining has a similar effect—unions are able that had a higher real value than had been expected.
to raise the wage above the equilibrium level. This will act Tackle the Test:
like a minimum wage by causing the number of job seek-
ers to be larger than the number of workers firms are Multiple-Choice Questions
willing to hire. Collective bargaining causes the unem- 1. e
ployment rate to be higher than it otherwise would be, as
shown in the accompanying figure. 2. c
3. b
Wage 4.
rate Labor supply d
Unemployed
5. c
W U Tackle the Test:
E Union- Free-Response Question
negotiated
W E
wage 2. a. 0%
b. You borrowed enough money to buy a couch and paid
back just enough to buy the same couch (after inflation).
Labor demand
Therefore, you gained the benefit of the loan without
Quantity
Q D Q E Q S paying any real interest for it.
of labor
c. Whoever gave you the loan lost. The loan was paid back
after prices unexpectedly increased, so the lender received
3. An increase in unemployment benefits reduces the cost to a real interest rate of 0% for letting you use the money
individuals of being unemployed, causing them to spend for a year.
more time searching for a new job. So the natural rate of
unemployment would increase. Module 15
Tackle the Test: Check Your Understanding
Multiple-Choice Questions 1. Pre – frost, this market basket costs (100 × $0.20) + (50 ×
1. a $0.60) + (200 × $0.25) = $20 + $30 + $50 = $100. The
same market basket, post - frost, costs (100 × $0.40) +
2. c (50 × $1.00) + (200 × $0.45) = $40 + $50 + $90 = $180.
3. b So the price index is ($100/$100) × 100 = 100 before the
4. d frost and ($180/$100) × 100 = 180 after the frost, imply-
ing a rise in the price index of 80%. This increase in the
5. e price index is less than the 84.2% increase calculated in
Tackle the Test: the text. The reason for this difference is that the new
market basket of 100 oranges, 50 grapefruit, and 200
Free-Response Question lemons contains proportionately more of an item that
has experienced a relatively small price increase (the
2. a. Frictional. Melanie is between jobs. lemons, the price of which has increased by 80%) and
b. Structural. Melanie is unemployed because wages are not
at the market equilibrium. proportionately fewer of an item that has experienced a
c. Cyclical. Melanie is unemployed due to an economic relatively large price increase (the oranges, the price of
slowdown (recession). which has increased by 100%). This shows that the price
index can be very sensitive to the composition of the
Module 14 market basket. If the market basket contains a large pro-
portion of goods whose prices have risen faster than the
Check Your Understanding prices of other goods, it will lead to a higher estimate of
the increase in the price level. If it contains a large pro-
1. Shoe-leather costs as a result of inflation will be lower portion of goods whose prices have risen more slowly
because it is now less costly for individuals to manage than the prices of other goods, it will lead to a lower esti-
their assets in order to economize on their money hold- mate of the increase in the price level.